Notes
to Condensed Financial Statements
December
31, 2020
(Unaudited)
NOTE
1 – ORGANIZATION AND NATURE OF BUSINESS
GulfSlope
Energy, Inc. (the “Company“ or “GulfSlope“) is an independent oil and natural gas exploration company
whose interests are concentrated in the United States Gulf of Mexico federal waters offshore Louisiana. The Company currently
has under lease three federal Outer Continental Shelf blocks (referred to as “prospect,“ “portfolio“ or
“leases“) and licensed three-dimensional (3-D) seismic data across its area of concentration.
NOTE
2 – SIGNIFICANT ACCOUNTING POLICIES
The
condensed financial statements included herein are unaudited. However, these condensed financial statements include all adjustments
(consisting of normal recurring adjustments), which, in the opinion of management are necessary for a fair presentation of financial
position, results of operations and cash flows for the interim periods. The results of operations for interim periods are not
necessarily indicative of the results to be expected for an entire year. The preparation of financial statements in accordance
with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts
reported in the Company’s condensed financial statements and accompanying notes. Actual results could differ materially
from those estimates.
Certain
information, accounting policies, and footnote disclosures normally included in the financial statements prepared in accordance
with accounting principles generally accepted in the United States of America (“GAAP“) have been omitted pursuant
to certain rules and regulations of the Securities and Exchange Commission (“SEC“). The condensed financial statements
should be read in conjunction with the audited financial statements for the year ended September 30, 2020, which were included
in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2020 and filed with the Securities and
Exchange Commission on December 29, 2020.
Cash
GulfSlope
considers highly liquid investments with original maturities to the Company of three months or less to be cash equivalents. There
were no cash equivalents at December 31, 2020 and September 30, 2020.
Liquidity
/ Going Concern
The
Company has incurred accumulated losses as of December 31, 2020 of $58.3 million, has negative working capital of $10.8 million
and for the three months ended December 31, 2020 generated losses of $0.1 million. Further losses are anticipated in developing
our business. As a result, there exists substantial doubt about our ability to continue as a going concern. As of December 31,
2020, we had $2.6 million of unrestricted cash on hand. The Company estimates that it will need to raise a minimum of $10.0 million
to meet its obligations and planned expenditures. The $10.0 million is comprised primarily of capital project expenditures as
well as general and administrative expenses. It does not include any amounts due under outstanding debt obligations, which amounted
to $11.7 million of current principal and accrued interest as of December 31, 2020. The Company plans to finance operations and
planned expenditures through the issuance of equity securities, debt financings and farm-out agreements, asset sales or mergers.
The Company also plans to extend the agreements associated with all loans, the accrued interest payable on these loans, as well
as the Company’s accrued liabilities. There are no assurances that financing will be available with acceptable terms, if
at all, or that obligations can be extended. If the Company is not successful in obtaining financing or extending obligations,
operations would need to be curtailed or ceased, or the Company would need to sell assets or consider alternative plans up to
and including restructuring. The financial statements do not include any adjustments that might result from the outcome of this
uncertainty.
Accounts
Receivable
The
Company records an accounts receivable for operations expense reimbursements due from joint interest partners and also from normal
operations. The Company estimates allowances for doubtful accounts based on the aged receivable balances and historical losses.
If the Company determines any account to be uncollectible based on significant delinquency or other factors, the receivable and
the underlying asset are assessed for recovery. As of December 31, 2020 and September 30, 2020, there was no allowance for doubtful
accounts receivable. Gross accounts receivable was nil and approximately $0.4 million at December 31, 2020 and September 30, 2020,
respectively.
Full
Cost Method
The
Company uses the full cost method of accounting for its oil and gas exploration and development activities. Under the full cost
method of accounting, all costs associated with successful and unsuccessful exploration and development activities are capitalized
on a country-by-country basis into a single cost center (“full cost pool“). Such costs include property acquisition
costs, geological and geophysical (“G&G“) costs, carrying charges on non-producing properties, costs of drilling
both productive and non-productive wells. Overhead costs, which includes employee compensation and benefits including stock-based
compensation, incurred that are directly related to acquisition, exploration and development activities are capitalized. Interest
expense is capitalized related to unevaluated properties and wells in process during the period in which the Company is incurring
costs and expending resources to get the properties ready for their intended purpose. For significant investments in unproved
properties and major development projects that are not being currently depreciated, depleted, or amortized and on which exploration
or development activities are in progress, interest costs are capitalized. Proceeds from property sales will generally be credited
to the full cost pool, with no gain or loss recognized, unless such a sale would significantly alter the relationship between
capitalized costs and the proved reserves attributable to these costs. A significant alteration would typically involve a sale
of 25% or more of the proved reserves related to a single full cost pool.
Proved
properties are amortized on a country-by-country basis using the units of production method (“UOP“), whereby capitalized
costs are amortized over total proved reserves. The amortization base in the UOP calculation includes the sum of proved property,
net of accumulated depreciation, depletion and amortization (“DD&A“), estimated future development costs (future
costs to access and develop proved reserves), and asset retirement costs, less related salvage value.
The
costs of unproved properties and related capitalized costs (such as G&G costs) are withheld from the amortization calculation
until such time as they are either developed or abandoned. Unproved properties and properties under development are reviewed for
impairment at least quarterly and are determined through an evaluation that considers, among other factors, seismic data, requirements
to relinquish acreage, drilling results, remaining time in the commitment period, remaining capital plan, and political, economic,
and market conditions. In countries where proved reserves exist, exploratory drilling costs associated with dry holes are transferred
to proved properties immediately upon determination that a well is dry and amortized accordingly. In countries where a reserve
base has not yet been established, impairments are charged to earnings. At December 31, 2020 the Company continues to pursue the
development of its unproved properties and is actively finalizing the permitting of the Tau #2 well. As such, project economics
continue to support cost incurred plus future development therefore no impairment is required at December 31, 2020.
Companies
that use the full cost method of accounting for oil and natural gas exploration and development activities are required to perform
a ceiling test calculation each quarter. The full cost ceiling test is an impairment test prescribed by SEC Regulation S-X Rule
4-10. The ceiling test is performed quarterly, on a country-by-country basis, utilizing the average of prices in effect on the
first day of the month for the preceding twelve-month period. The cost center ceiling is defined as the sum of (a) estimated future
net revenues, discounted at 10% per annum, from proved reserves, (b) the cost of properties not being amortized, if any, and (c)
the lower of cost or market value of unproved properties included in the cost being amortized. If such capitalized costs exceed
the ceiling, the Company will record a write-down to the extent of such excess as a non-cash charge to earnings. Any such write-down
will reduce earnings in the period of occurrence and results in a lower depreciation, depletion and amortization rate in future
periods. A write-down may not be reversed in future periods even though higher oil and natural gas prices may subsequently increase
the ceiling.
The
Company capitalizes exploratory well costs into oil and gas properties until a determination is made that the well has either
found proved reserves or is impaired. If proved reserves are found, the capitalized exploratory well costs are reclassified to
proved properties. The well costs are charged to expense if the exploratory well is determined to be impaired. The Company is
currently evaluating one well for proved reserves and capitalized exploratory well costs remain pending the outcome of exploration
activities involving the drilling of the Tau No. 2 well (twin well). Accordingly, these costs are included as suspended well costs
at December 31, 2020 and it is expected that a final analysis will be completed in the next twelve months at which time the costs
will be transferred to the full cost pool upon final evaluation.
As
of December 31, 2020, the Company’s oil and gas properties consisted of unproved properties, wells in process and no proved
reserves.
Due
to a combination of the COVID-19 pandemic and related pressures on the global supply-demand balance for crude oil and related
products, commodity prices have significantly declined in recent months, and oil and gas operators have reduced exploration budgets
and activity. The Company has evaluated the effect of these factors on its business and notes these factors have caused a delay
in the plans for the Company’s 2021 drilling program. The Company continues to monitor the economic environment and evaluate
the impact on the business.
Asset
Retirement Obligations
The
Company’s asset retirement obligations will represent the present value of the estimated future costs associated with plugging
and abandoning oil and natural gas wells, removing production equipment and facilities and restoring the seabed in accordance
with the terms of oil and gas leases and applicable state and federal laws. Determining asset retirement obligations requires
estimates of the costs of plugging and abandoning oil and natural gas wells, removing production equipment and facilities and
restoring the sea bed as well as estimates of the economic lives of the oil and gas wells and future inflation rates. The resulting
estimate of future cash outflows will be discounted using a credit-adjusted risk-free interest rate that corresponds with the
timing of the cash outflows. Cost estimates will consider historical experience, third party estimates, the requirements of oil
and natural gas leases and applicable local, state and federal laws, but do not consider estimated salvage values. Asset retirement
obligations will be recognized when the wells drilled reach total depth or when the production equipment and facilities are installed
or acquired with an associated increase in proved oil and gas property costs. Asset retirement obligations will be accreted each
period through depreciation, depletion and amortization to their expected settlement values with any difference between the actual
cost of settling the asset retirement obligations and recorded amount being recognized as an adjustment to proved oil and gas
property costs. Cash paid to settle asset retirement obligations will be included in net cash provided by operating activities
from continuing operations in the statements of cash flows. On a quarterly basis, when indicators suggest there have been material
changes in the estimates underlying the obligation, the Company reassesses its asset retirement obligations to determine whether
any revisions to the obligations are necessary. At least annually, the Company will assess all of its asset retirement obligations
to determine whether any revisions to the obligations are necessary. Future revisions could occur due to changes in estimated
costs or well economic lives, or if federal or state regulators enact new requirements regarding plugging and abandoning oil and
natural gas wells. The Company drilled two well bores in 2018 and 2019 and these wellbores were both plugged with no further cost
required and as such, the asset retirement obligation was completely extinguished.
Derivative
Financial Instruments
The
accounting treatment of derivative financial instruments requires that the Company record
certain embedded conversion options and warrants as liabilities at their fair value as of the inception date of the agreement
and at fair value as of each subsequent balance sheet date with any change in fair value recorded as income or expense. As a result
of entering into certain note agreements, for which such instruments contained a variable conversion feature with no floor, the
Company had adopted a sequencing policy in accordance with ASC 815-40-35-12 whereby all future instruments issued after
such variable conversion feature instruments may be classified as a derivative liability with the exception of instruments related
to share-based compensation issued to employees or directors, as long as the certain variable convertible instruments exist. During
the three months ended December 31, 2020, the variable conversion feature instruments have been extinguished or modified to remove
the variable conversion feature. See Note 7.
Basic
and Dilutive Earnings Per Share
Basic
income (loss) per share (“EPS“) is computed by dividing net income (loss) (the numerator) by the weighted average
number of common shares outstanding for the period (denominator). Diluted EPS is computed by dividing net income (loss) by the
weighted average number of common shares and potential common shares outstanding (if dilutive) during each period. Potential common
shares include stock options, warrants, and convertible notes payable. The number of potential common shares outstanding relating
to stock options and warrants, is computed using the treasury stock method. The number of potential common shares related to convertible
notes payable is determined using the if-converted method.
As
the Company has incurred losses for the three months ended December 31, 2020 and 2019, the potentially dilutive shares are anti-dilutive
and are thus not added into the loss per share calculations. As of December 31, 2020 and 2019, there were 256,011,343 and 437,801,388
potentially dilutive shares, respectively.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those
estimates.
Recent
Accounting Pronouncements
In
February 2016, the FASB issued ASU No. 2016-02, “Leases,“ and in March 2019, the FASB issued ASU No. 2019-01, “Leases:
Codification Improvements“, which updated the accounting guidance related to leases to increase transparency and comparability
among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about
leasing arrangements. They also clarify implementation issues. These updates are effective for public companies for annual periods
beginning after December 15, 2018, including interim periods therein. Accordingly, the standard was adopted by the Company on
October 1, 2019. The standard was applied utilizing a modified retrospective approach and is reflected in these financial statements.
In
June 2018, the FASB issued ASU 2018-07, Compensation-Stock Compensation (Topic 718), Improvements to Nonemployee Share-based
Payments (“ASU 2018-07“). This ASU expands the scope of Topic 718 to include share-based payment transactions for
acquiring goods and services from nonemployees. The amendments in this ASU are effective for public companies for fiscal years
beginning after December 15, 2018, including interim periods within that fiscal year. The Company adopted this new standard effective
October 1, 2019 with no material impact to stock compensation issued to non-employees.
The
Company has evaluated all other recent accounting pronouncements and believes that none of them will have a significant effect
on the Company’s financial statements.
NOTE
3 – OIL AND NATURAL GAS PROPERTIES
The
Company currently has under lease three federal Outer Continental Shelf blocks and has licensed 2.2 million acres of three-dimensional
(3-D) seismic data in its area of concentration.
The
Company, as the operator of two wells drilled in the Gulf of Mexico, has incurred tangible and intangible drilling costs for the
wells in process and has billed its working interest partners for their respective share of the drilling costs to date. The intangible
drilling and all other costs related to the first well have been impaired. The second well, Tau, was drilled to a measured depth
of 15,254 feet, as compared to the originally permitted 29,857 foot measured depth. Producible hydrocarbon zones were not established
to that depth, but hydrocarbon shows were encountered. Complex geomechanical conditions required two by-pass wellbores, one sidetrack
wellbore, and eight casing strings to reach that depth. Equipment limitations prevented further drilling. In addition, the drilling
rig had contractual obligations related to another operator. The Company elected to plug this well in a manner that would allow
for re-entry at a later time. The Company is evaluating various options related to future operations in this wellbore and testing
of the deeper Tau prospect. The Company plans to re-drill this prospect within the next twelve months, however, the impact of
the CoVid-19 pandemic on offshore operations is still under mitigation by operators
and will influence the potential timing of a re-drill.
In
January 2019, the Tau well experienced an underground control of well event and as a result, the Company filed an insurance claim
pursuant to its insurance policy with its insurance underwriters (the “Underwriters“). The total amount of the claim
was approximately $10.8 million for 100% working interest after the insurance deductible amount. The Company received approximately
$2.5 million of this amount and credited wells in process for approximately $0.9 million for the Company’s portion, and
recorded an accrued payable for approximately $1.6 million, pending evaluation of distributions to the working interest owners.
In December 2019, the accrued payable was settled by the issuance to the working interest partner of approximately 38.4 million
shares of the Company’s common stock.
In
May 2019, the Tau No. 1 well experienced a second underground control of well event and as a result, the Company filed an
insurance claim. The claim was related to a subsurface well occurrence that happened during the drilling of the Company‘s
Tau No. 1 well on May 5, 2019 at a measured depth of 15,254 feet. The Company subsequently controlled the occurrence and ceased
drilling operations and plugs were placed in the well to meet regulatory requirements prior to rig release. Pursuant to the Policy
terms and conditions, the Underwriters were obligated to reimburse GulfSlope for qualified actual costs and expenses incurred
to (i) regain control of the well, and (ii) restore or re-drill the well to 15,254 feet. Total costs and expenses to regain control
of the well were determined to be approximately $4.8 million (net of deductible) for 100% working interest and all of this amount
had been received as of December 31, 2020. GulfSlope’s share of this amount was approximately $1.2 million.
In
November 2019, an agreement was reached with a working interest partner whereby the working interest partner re-conveyed to the
Company their 5% interest in Tau and Canoe in exchange for the release of claims and the Company foregoing collection of accounts
receivable owed by the working interest partner. As a result of this agreement approximately $3.6 million of accounts receivable
was reclassified to oil and gas properties – unproved during the year ended September 30, 2020.
On
July 27, 2020, the Company entered into a settlement with the Underwriters of the well control events insurance policy for their
claims associated with the re-drilling of the Tau No. 1 well. In accordance with the settlement, in lieu of the insurer paying
for the redrill of the well and for a complete release of any further liability under the insurance policy, the Company will receive
approximately $6.6 million in cash net to its 25% working interest. At December 31, 2020, all of this amount has been received.
As
of December 31, 2020, the Company’s oil and natural gas properties consisted of unproved properties, wells in process and
no proved reserves. During the three months ended December 31, 2020 and 2019, the Company capitalized approximately nil and $0.4
million of interest expense to oil and natural gas properties, respectively, and approximately $0.03 million and $0.3 million
of general and administrative expenses, capitalized to oil and natural gas properties, respectively.
NOTE
4 – RELATED PARTY TRANSACTIONS
During
April 2013 through September 2017, the Company entered into convertible promissory notes whereby it borrowed a total of $8,675,500
from John Seitz, the chief executive officer (“CEO“). The notes are due on demand, bear interest at the rate of 5%
per annum, and $5,300,000 of the notes are convertible into shares of common stock at a conversion price equal to $0.12 per share
of common stock (the then offering price of shares of common stock to unaffiliated investors). As of December 31, 2020, the total
amount owed to John Seitz is $8,675,500. This amount is included in loans from related parties within the condensed balance sheets.
There was approximately $2.6 million of unpaid interest associated with these loans included in accrued interest payable within
the balance sheet as of December 31, 2020.
On
November 15, 2016, a family member of the CEO entered into a $50,000 convertible promissory note with associated warrants (“Bridge
Financing“) under the same terms received by other investors (see Note 5).
Domenica Seitz CPA, related to John Seitz,
has provided accounting services to the Company through September 30, 2020 as a consultant and beginning October 2020 as an employee.
During the three months ended December 31, 2020 and 2019, the services provided were valued at approximately $19,000 and $15,000,
respectively.
NOTE 5 – NOTES PAYABLE
The Company’s notes payable consisted of the following
as of September 30, 2020 and December 31, 2020.
|
|
September 30,
2020
|
|
|
December 31,
2020
|
|
|
PPP Loan Payable
|
|
$
|
100,300
|
|
|
$
|
0
|
|
|
Insurance Note Payable
|
|
|
20,527
|
|
|
|
0
|
|
|
Total
|
|
$
|
120,827
|
|
|
$
|
0
|
|
|
PPP Loan
On April 16, 2020, GulfSlope Energy, Inc.
entered into a promissory note (the “Note“) evidencing an unsecured $100,300 loan under the Paycheck Protection Program
(the “PPP Loan“). The Paycheck Protection Program was established under the Coronavirus Aid, Relief, and Economic Security
Act (the “CARES Act“) and is administered by the U.S. Small Business Administration. The PPP Loan was made through
Zions Bancorporation, N.A. dba Amegy Bank (the “Lender“). On December 17, 2020, the PPP Loan plus accrued interest
of approximately $600 was formally forgiven in full by the U.S. Small Business Administration. The forgiven loan balance and related
interest totaling approximately $100,900 was accounted for as a gain on debt extinguishment in the Condensed Statements of Operations
during the three months ended December 31, 2020.
Insurance Note Payable
In November 2019, the Company purchased
an insurance policy for approximately $241,000 and financed $220,629 of the premium by executing a note payable at an interest
rate of 5.6%. The note was paid in full with the October 2020 payment. The balance of the note payable was nil and approximately
$21,000 at December 31, 2020 and September 30, 2020, respectively. This note is included in the Notes Payable balance in the Condensed
Balance Sheet.
NOTE 6 – CONVERTIBLE NOTES PAYABLE
The Company’s convertible promissory
notes consisted of the following as of September 30, 2020 and December 31, 2020.
|
|
September 30, 2020
|
|
|
December 31, 2020
|
|
|
|
Notes
|
|
|
|
Discount
|
|
|
|
Notes, Net
of Discount
|
|
|
|
Notes
|
|
|
|
Discount
|
|
|
|
Notes Net
of Discount
|
|
|
Bridge Financing Notes
|
|
$
|
227,000
|
|
|
|
$
|
(11,209
|
)
|
|
|
$
|
215,791
|
|
|
|
$
|
227,000
|
|
|
|
$
|
(6,344)
|
|
|
|
$
|
220,656
|
|
|
June 2019 Convertible Debenture
|
|
|
300,000
|
|
|
|
|
(54,178
|
)
|
|
|
|
245,822
|
|
|
|
|
0
|
|
|
|
|
0
|
|
|
|
|
0
|
|
|
Total
|
|
$
|
527,000
|
|
|
|
$
|
(65,387
|
)
|
|
|
$
|
461,613
|
|
|
|
$
|
227,000
|
|
|
|
$
|
(6,344)
|
|
|
|
$
|
220,656
|
|
|
Bridge Financing
Notes
Between June and November 2016, the Company
issued eleven convertible promissory notes (“Bridge Financing Notes“) with associated warrants in a private placement
to accredited investors for total gross proceeds of $837,000, including $222,000 from related parties. These notes and associated
warrants had a maturity of one year (which has been extended at maturity to April 30, 2021), an annual interest rate of 8% and
can be converted at the option of the holder at a conversion price of $0.025 per share. In addition, the convertible notes will
automatically convert if a qualified equity financing of at least $3 million occurs before maturity and such mandatory conversion
price will equal the effective price per share paid in the qualified equity financing. The note balances as of December 31, 2020
and September 30, 2020 were $277,000, with unamortized debt discounts of approximately $6,000 and $11,000, respectively. Debt discount
amortization for the three months ended December 31, 2020 and 2019 was approximately $5,000 and $43,000, respectively. As noted
above, on April 30, 2020, the maturity date related to these notes and associated warrants was extended to April 30, 2021. In consideration
for the extension of the notes in April 2020, the Company extended the term of the related warrants until April 30, 2021 and recognized
$19,300 of additional debt discount which represented the incremental value of the modified warrants over the pre-modification
warrants.
Delek Note
On March 1, 2019, the Company entered into
a term loan agreement with Delek, where Delek agreed to provide the Company with multiple draw term loans in an aggregate stated
principal amount of up to $11.0 million, of which $10.0 million was initially advanced and subsequently converted to equity through
the exercise of a warrant. The maturity date of the facility was September 4, 2019, and until such time any loans would bear interest
at a rate per annum equal to 5.0% or 7% upon the occurrence of default. Amounts outstanding under the Term Loan Agreement are secured
by a security interest in substantially all of the properties and assets of the Company. On April 19, 2019, the Company borrowed
the remaining $1.0 million under this agreement.
The term loan facility expired as of September
4, 2019, and in October 2019, the Company signed a Post-Drilling Agreement with Delek modifying this arrangement. The Post-Drilling
Agreement states that as payoff for the Company’s outstanding obligations of $1,000,000 plus accrued interest (and additional
fees of approximately $200,000), the Company shall issue a convertible note payable to Delek in the amount of $1,220,548. The new
note is convertible at the option of Delek at a conversion price of $0.05 per share, and in the event of default the conversion
rate adjusts to 60% of the lowest volume weighted average price in the previous 20 trading days. Interest on the note accrues at
12% per annum (15% upon default) and the maturity of the note is October 22, 2020. The Company has a right to prepay all principal
and accrued interest prior to maturity.
The Company accounted for the October 2019
transaction as an extinguishment of the prior note given the addition of the substantive conversion feature discussed above. In
addition, The Company concluded that the embedded conversion feature within the note requires derivative accounting treatment under
ASC 815, Derivatives and Hedging due to the potential variable conversion feature which lacks an explicit limit on the number
of shares that may be required upon conversion. Accordingly, the Company valued the embedded conversion feature and host instrument
at their fair values of $479,498 and $1,220,548, respectively, and recognized a loss on extinguishment of $676,785. The fair value
of the host note was determined by discounting the future cash flows of the note at a market participant-based rate of interest.
Further, since the embedded conversion feature is a derivative liability, it is subsequently remeasured to fair value each reporting
period.
On September 30, 2020, the Company and
Delek settled this convertible note and related accrued interest of $129,211 for a cash payment of $1,220,548 and the issuance
17,500,000 shares of common stock. The shares were not issued until October 2020 and accordingly are reflected on the September
30, 2020 Condensed Balance Sheet as additional paid in capital – shares to be issued.
June 2019 Convertible
Debenture
On June 21, 2019, the Company entered into
a securities purchase agreement to borrow up to $3,000,000 through the issuance of convertible debentures (“Convertible Debentures”)
and associated warrants. On June 21, 2019, approximately $2,100,000 (“Tranche 1”) of Convertible Debentures were purchased
with other tranches closing on August 7, 2019 for $400,000 (“Tranche 2”) and November 6, 2019 (“Tranche 3”)
for $500,000. All tranches accrue interest at eight percent per annum, and mature one year after each respective closing date,
and are convertible at the option of the holder any time after issuance into common stock at a conversion rate of the lesser of:
(1) $0.05 per share; or (2) 80% of the lowest volume weighted adjusted price (as reported by Bloomberg, LP) for the ten consecutive
trading days immediately preceding conversion, and in the event of default the conversion rate adjusts to 60% of the lowest volume
weighted average price in the previous 20 trading days.
In addition, the holder received warrants
to purchase an aggregate of 50 million shares of common stock at an exercise price of $0.04 per share (subsequently reduced to
an exercise price $0.02 in 2020). Such warrants expire on the fifth anniversary of issuance. In total the offering costs incurred
related to this Convertible Debenture were approximately $398,000.
The Company evaluated the conversion feature
and concluded that it should be bifurcated and accounted for as a derivative liability due to the variable conversion feature which
does not contain an explicit limit on the number of shares that are required to be issued upon conversion. In addition, the Company
concluded the warrants required treatment as derivative liabilities as the Company could not assert it has sufficient authorized
but unissued shares to settle the warrants upon exercise when taking into account other stock-based commitments including the Convertible
Debentures. Accordingly, the embedded conversion feature and warrants were recorded at fair value at issuance and are subsequently
re-measured to fair value each reporting period.
In June 2020, the Company extended the
maturity dates of Tranche 1 and Tranche2 to August 21, 2020 in exchange for a cash payment of $50,000. The extension was treated
as a modification for accounting purposes which resulted in the $50,000 being recognized as an additional debt discount allocated
on a pro-rata basis between Tranche 1 and Tranche 2 and will be amortized using the effective interest method over the remaining
life of the respective tranches.
On July 27, 2020, the Company and the holder
agreed to the following cash payments in full satisfaction of the obligations thereunder: (1) $50,000 on the date of the Agreement;
(2) $700,000 on or before August 21, 2020; (3) $750,000 on or before September 30, 2020; and (4) any remaining principal amount
outstanding on or before November 30, 2020. As of the date of the agreement, the principal balance outstanding on the Convertible
Debenture was $1,900,000, which amount may be reduced in the event that holder elects to convert to equity all or any portion of
principal prior to repayment. In connection with the agreement, the holder agreed not to convert more than $300,000 of principal
of the Debenture between the date of the agreement and November 30, 2020. Upon the timely payment by the Company of the amounts
set forth above, all other amounts due on the Debentures, including any interest or fees accrued or that will accrue or become
due or payable on the Debentures, will be extinguished. The Company accounted for this arrangement as a modification of the existing
debt.
During the year ended September 30, 2020,
the lender converted approximately $1,200,000 of principal of Tranche 1 and approximately $139,000 of accrued interest into common
stock. The remaining balance of the convertible debenture at September 30, 2020 was $300,000.
In November 2020, the Company made a $300,000
payment in full to satisfy the remaining balance of the convertible debenture.
The fair value of the embedded conversion
feature at September 30, 2020 was determined utilizing a Geometric Brownian Motion Stock Path Based Monte Carlo Simulation that
utilized the following key assumptions:
|
|
|
|
|
|
September 30, 2020
|
|
Stock Price
|
|
|
|
|
|
$
|
0.006
|
|
Fixed Exercise Price
|
|
|
|
|
|
$
|
0.05
|
|
Volatility
|
|
|
|
|
|
|
122
|
%
|
Term (Years)
|
|
|
|
|
|
|
0.17
|
|
Risk Free Rate
|
|
|
|
|
|
|
0.10
|
%
|
In addition to the fixed exercise price
noted above, the model incorporated the variable conversion price which is simulated as 80% of the lowest trading price within
the ten consecutive days preceding presumed conversion.
NOTE 7 – FAIR VALUE MEASUREMENT
Fair value is defined as the price that
would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date. Fair value measurements are classified and disclosed in one of the following categories:
Level 1:
|
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. The Company considers active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
|
Level 2:
|
Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that the Company values using observable market data. Substantially all of these inputs are observable in the marketplace throughout the term of the derivative instrument, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category include non-exchange traded derivative financial instruments as well as warrants to purchase common stock and long-term incentive plan liabilities calculated using the Black-Scholes model to estimate the fair value as of the measurement date.
|
Level 3:
|
Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e. supported by little or no market activity).
|
As required by ASC 820-10, financial assets
and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company’s
assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation
of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.
Fair Value on a Recurring Basis
The following table sets forth by level
within the fair value hierarchy the Company’s derivative financial instruments that were accounted for at fair value on a
recurring basis as of September 30, 2020 and December 31, 2020, respectively:
Description
|
|
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
|
|
|
Significant Other
Observable Inputs
(Level 2)
|
|
|
Significant Other
Unobservable
Inputs
(Level 3)
|
|
|
Total Fair
Value as of
|
|
Derivative Financial Instrument at September 30, 2020
|
|
$
|
|
|
|
$
|
(1,070,551)
|
|
|
$
|
|
|
|
$
|
(1,070,551)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative Financial Instrument at December 31, 2020
|
|
$
|
—
|
|
|
$
|
(972,552)
|
|
|
$
|
—
|
|
|
$
|
(972,552)
|
|
The change in derivative financial instruments for the three
months ended December 31, 2020 is as follows:
September 30, 2020 balance
|
|
$
|
(1,070,551)
|
|
New derivative instruments issued
|
|
|
—
|
|
Derivative instruments extinguished
|
|
|
46,261
|
|
Change in fair value
|
|
|
51,738
|
|
December 31, 2020 balance
|
|
$
|
(972,552)
|
|
Non-recurring fair value assessments include
stock-based compensation. The Company recorded stock-based compensation of nil and $367,841 for the three months ended December
31, 2020 and 2019, respectively.
NOTE 8 – COMMON STOCK/PAID IN
CAPITAL
Three Months Ended December 31, 2020
As noted in Note 6, in October 2020 the
Company issued approximately 17.5 million common shares with a fair value of approximately $0.1 million that were reflected on
the September 30, 2020 balance sheet as additional paid in capital – shares to be issued
Three Months Ended December 31, 2019
The Company issued 17,919,455 common shares
with a fair value of $548,391 upon partial conversions of the notes and related accrued interest during the three months ended
December 31, 2019. The common shares were valued based upon the closing common share prices on the respective conversion dates.
The Company issued 38,423,221 common shares
with a fair value of $1,536,929 to extinguish an accrued expense that totaled $1,613,775 during the three months ended December
31, 2019. The common shares were valued based upon the closing common share price on the date of settlement resulting in a gain
on the extinguishment of the obligation of approximately $77,000.
NOTE 9 – STOCK-BASED COMPENSATION
Stock-based compensation cost is measured
at the grant date, based on the estimated fair value of the award using the Black Scholes option pricing model, and is recognized
over the vesting period. The Company recognized stock based compensation of nil and $367,841 for the three months ended December
31, 2020 and 2019, respectively. Of the $367,841 of stock based compensation recognized for the three months ended December 31,
2019, $186,675 was capitalized to unproved oil and gas properties, with the remainder recorded as general and administrative
expenses for each respective period.
During the three months ended December
31, 2019, upon the passing of a member of the management team, the Company modified a stock option grant for three million shares
made to said management team member in June 2018 to vest such award immediately. The Company recorded approximately $8,000 in additional
compensation expense related to this modification.
The following table summarizes the Company’s
stock option activity during the three months ended December 31, 2020:
|
|
Number of Options
|
|
|
Weighted Average
Exercise Price
|
|
|
Weighted Average
Remaining
Contractual Term
(In years)
|
|
Outstanding at September 30, 2020
|
|
|
104,500,000
|
|
|
$
|
0.0605
|
|
|
|
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Outstanding at December 31, 2020
|
|
|
104,500,000
|
|
|
$
|
0.0605
|
|
|
|
4.3
|
|
Vested and expected to vest
|
|
|
104,500,000
|
|
|
$
|
0.0605
|
|
|
|
4.3
|
|
Exercisable at December 31, 2020
|
|
|
104,500,000
|
|
|
$
|
0.0565
|
|
|
|
4.3
|
|
As of December 31, 2020, there was no unrecognized
stock-based compensation expense.
NOTE 10 – COMMITMENTS AND CONTINGENCIES
From time to time, the Company may become
involved in litigation relating to claims arising out of its operations in the normal course of business. No legal proceedings,
government actions, administrative actions, investigations or claims are currently pending against us or involve the Company.
In July 2018, the Company entered
into a 39 month lease for approximately 5,000 square feet of office space in 4 Houston Center in downtown Houston. Annual
base rent is approximately $94,000 for the first 18 months, increasing to approximately $97,000 and $99,000, respectively,
during the remaining term of the lease. The Company accounted for this lease as an operating lease in accordance with ASC
842, Leases. At December 31, 2020, the right-of-use asset, net related to this lease is $41,441 and the operating lease
liability is $67,271. All remaining payments totaling approximately $74,000 are payable within the current fiscal year.
The Company reached an agreement in August
2018 for the settlement of approximately $1 million in debt owed to a third party. As required under the terms of the settlement,
the Company made a payment of approximately $0.16 million in cash and 10 million shares of common stock at such time. The agreement
also contained a provision such that upon the sale of the common stock by the holder, if the proceeds received were not sufficient
to fully satisfy the original debt balance, additional payment by the Company will be made under a mutually agreed payment plan.
If the stock is sold for a gain any surplus in excess of $1.3 million shall be a credit against future purchases. The agreement
was determined to meet the definition of a derivative in accordance with ASC 815. At December 31, 2020, there is a derivative financial
instrument liability recorded of approximately $0.8 million related to this agreement.
NOTE 11 – SUBSEQUENT
EVENTS
The Company completed a review and analysis
of all events that occurred after the condensed balance sheet date to determine if any such events must be reported and has determined
that there are no other subsequent events to be disclosed.